The financial manager of the Villard Electric Company, Fred Taylor, has presented his estimates of cash flows resulting from the possible investment in a new computer system, the Webnet. Mr. Taylor’s estimates of net cash flows immediately and over the following four years are as follows:

Mr. Taylor has based his estimates on the following assumptions:
■ The cost of the system (including installation) is $200,000.
■ The system will be depreciated as a 5-year asset under the MACRS, but it will be sold at the end of the fourth year for $50,000.
■ Villard’s expenses will decline by $50,000 in each of the four years.
■ The company’s tax rate will be 36%.
■ Working capital will not be affected.
When he made his presentation to Villard’s board of directors, Mr. Taylor was asked to perform additional analyses to consider the following uncertainties:
■ The cost of the system may be as much as 20% higher or as low as 20% lower.
■ The change in expenses may be 30% higher or 20% lower than anticipated.
■ The tax rate may be lowered to 30%.

a. Reestimate the project’s cash flows to consider each of the possible variations in the assumptions, altering only one assumption each time. Using a spreadsheet program will help with the calculations.

b. Discuss the impact that each of the changes in assumptions has on the project’s cash flows.

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Item Purchase of computer system Initial First Year Second Year Third Year Fourth Year -$200,000 Sale of computer system $40,000 Tax on sale of computer system 12,442 Acquisition and disposition cash flows -$200,000 $0 $0 $0 $52,442 Change in expenses $50,000 $50,000 $50,000 $50,000 Change in depreciation 40,000 64,000 38,400 23,040 Change in taxable income $10,000 -$14,000 $11,600 $26,960 Less: change in tax 3,600 -5,040 4,176 9,706 Change in income after tax $6,400 -$8,960 $7,424 $17,254 Change in depreciation 40,000 64,000 38,400 23,040 Change in operating cash flows $46,400 $55,040 $45,824 $40,294 Change in net cash flows -$200,000 $46,400 $55,040 $45,824 $92,736